Felman v. Commissioner

Richard L. Felman, Petitioner v. Commissioner of Internal Revenue, Respondent Felman v. Commissioner Docket No. 6107-65 United States Tax Court 49 T.C. 599; 1968 U.S. Tax Ct. LEXIS 165; March 11, 1968, Filed *165 Decision will be entered for the respondent. In 1963 petitioner became entitled to, and received, readjustment pay in the amount of $ 12,600 under the provisions of the Act of June 28, 1962, Pub. L. 87-509, 87th Cong., 1st Sess., 76 Stat. 120, 50 U.S.C. sec. 1016. Held, the amount so received was includable in petitioner's gross income under sec. 61 (a), I.R.C. 1954, and was not excludable therefrom under sec. 113, I.R.C. 1954. William L. Raby, for the petitioner. Edward B. Simpson, for the respondent. Arundell, Judge. ARUNDELL *599 Respondent determined a deficiency in income tax for the calendar year 1963 in the amount of $ 3,555.08. One error is assigned by petitioner as follows: (a) In determining the taxable income of the petitioner for the year 1963, the Commissioner determined that the lump sum payment of $ 12,600 received *600 by the petitioner from the United States Government pursuant to Public Law 87-509, June 28, 1962, represents, and is taxable as, ordinary*167 income. FINDINGS OF FACT Some of the facts were stipulated. The stipulation, together with all the exhibits attached thereto, is incorporated herein by reference. Petitioner resided in Tucson, Ariz., at the time of the filing of his petition. He filed his Federal income tax return for the calendar year 1963 with the district director of internal revenue in Manhattan, New York. At the request of petitioner, his said return was transferred to the district director of internal revenue in Phoenix, Ariz. On or about January 15, 1963, petitioner, then serving as an Air Force Reserve officer on active duty with the rank of captain, was informed by letter from the U.S. Air Force that he would be involuntarily released from active duty as the result of having been twice considered but not recommended for promotion pursuant to paragraph 4f(1), Air Force Regs. 36-89. On July 31, 1963, petitioner was honorably released from active duty pursuant to paragraph 74, Air Force Regs. 36-12. Petitioner commenced his military career on July 24, 1942, with enlistment in the U.S. Army Reserve Corps. At the time of petitioner's release from the U.S. military service, he was serving on active duty in *168 the rank of captain. In addition, petitioner, at the time of his release, had attained the rank of major in the U.S. Air Force Reserves. Petitioner served a total of 14 years, 8 months, and 29 days on active duty. In 1963 petitioner received $ 12,600 as a lump-sum readjustment payment under the authority and provisions of the Act of June 28, 1962, Pub. L. 87-509, 87th Cong., 1st Sess., 76 Stat. 120, 50 U.S.C. sec. 1016. Pursuant to Pub. L. 87-509, the amount of petitioner's lump-sum readjustment payment was computed on the basis of 2 months' basic pay in the grade in which petitioner was serving at the time of his involuntary release from active duty for each year of active service. As of the date of the hearing herein, petitioner has never reenlisted in the Armed Forces of the United States and is not entitled to retirement pay. Petitioner's civilian career had been originally interrupted by his entry into the Air Force in 1942, following which he spent 6 years as a civilian, and then went back on active duty with the Air Force at the time of the Korean conflict in 1951. *601 Petitioner's Air Force occupation was one with no civilian counterpart. *169 This readjustment payment under Pub. L. 87-509 was "intended to provide these officers with a lump-sum payment which would enable them to readjust to civilian life, and it is not intended as a 'severance payment' for services previously rendered by the officer." (H. Rept. No. 1007, accompanying H.R. 8773, 87th Cong., 1st Sess., p. 5.) If petitioner had completed 20 years of service in the Air Force, he would have been entitled to retire and receive retirement pay, subject to the following provision of Pub. L. 87-509: (4) Subsection (c) is amended to read as follows: "(c) A member of a reserve component who has received a readjustment payment under this section after the date of enactment of this amended subsection and who qualifies for retired pay under any provision of title 10 or title 14, United States Code, that authorizes his retirement upon completion of 20 years of active service, may receive that pay subject to the immediate deduction from that pay of an amount equal to 75 percent of the amount of the readjustment payment, without interest." A major inducement to petitioner to remain in the Air Force during the years of his service had been the promise of retirement pay after*170 completion of 20 years of service. On his tax return for the year 1963 petitioner excluded from income the $ 12,600 that he received from the Air Force on the basis that it was not taxable to him. He reported the amount "as an offset against the accumulated retirement equity" of an amount computed by petitioner of $ 80,454. The respondent determined that the entire amount of $ 12,600 was taxable income and, in a statement attached to the deficiency notice, explained his determination thus: (a) It is determined that the sum of $ 12,600.00 received by you during the taxable year 1963 as readjustment pay, from the United States Government pursuant to Public Law 87-509, is taxable as ordinary income. Since you failed to include this amount as ordinary income on your return, your taxable income is increased $ 12,600.00. OPINION In substance, this case is controlled by our decision in Leland W. Woolard, 47 T.C. 274. The petitioner in that case in 1962 became entitled to and received readjustment pay in the amount of $ 12,300 under the provisions of Pub. L. 87-509, because he was involuntarily released from active duty as a Reserve officer in the U.S. Air*171 Force on June 30, 1962, after completion of approximately 16 years of service. The only difference in principle between the facts in petitioner's case and *602 Woolard's case is that petitioner did not reenlist, whereas Woolard did reenlist. Because Woolard reenlisted, he contended that, when it came time for him to retire, he would be obligated to commence "repaying" out of his retirement pay $ 9,225 (75 percent) of the $ 12,300 received from the Air Force as readjustment pay in August 1962 and that, therefore, the $ 9,225 should be excluded from his taxable income. Woolard conceded that the remaining 25 percent of the $ 12,300, or $ 3,075, was taxable income in 1962. We held that the entire amount of $ 12,300 was taxable in 1962 and, in our opinion, we said: In these circumstances the proper tax treatment of these payments is to treat the readjustment pay as taxable income when received in 1962, and to tax only the reduced amounts of retirement pay in future years when and if paid to petitioner. In short, petitioner is taxable upon the amounts actually received in the years that he receives them. Whether the case be looked upon as one with a reduced retirement*172 annuity in future years or one in which petitioner would be required to "repay" 75 percent of the readjustment pay out of that annuity, the result must be the same. For even if the latter view be taken, petitioner meanwhile had the unrestricted and uncontested right to use the entire readjustment pay for his own purposes, subject only to restoring a portion thereof out of retirement pay, if he should in fact retire in a later year. The mere fact that income received by a taxpayer may have to be returned at some later time does not deprive it of its character as taxable income when received. * * * Here the payment represented additional compensation for service in the Air Force. See Rev. Rul. 58-496, 1958-2 C.B. 20. It was income when received. Petitioner, however, contends that the Woolard case was a pro se case, and that the question of the applicability of section 113, I.R.C. 1954, 1 and certain other questions were not raised by either party in the Woolard case. *173 Section 113 has no application here. The substance of this section first made its appearance in tax law as section 22(b)(14) of the 1939 Code added by section 109 2 of the Revenue Act of 1943. The Mustering-Out Payment Act of 1944 (Act of Feb. 3, 1944, ch. 9, 58 Stat. 8), provided for payments to certain eligible persons ranging in amounts from $ 100 to $ 300. Section 5(a) of the Act stated in part: "Mustering-out payments due or to become due under this Act * * * shall be exempt from taxation * * *." The courts have consistently held that income received*174 by a taxpayer must be reported and is subject to tax in the absence of a specific *603 exemption. Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955); Gen. Investors Co. v. Commissioner, 348 U.S. 434 (1955). In the latter case, the Supreme Court said: As in Glenshaw, the taxpayer realized the money in question free of any restrictions as to use. The payments in controversy were neither capital contributions nor gifts. * * * There is no indication that Congress intended to exempt them from coverage. In accordance with the legislative design to reach all gain constitutionally taxable unless specifically excluded, we conclude that the petitioner is liable for the tax and the judgment is Affirmed. In the various Acts providing for mustering-out payments, Congress has clearly and specifically exempted such payments from taxation. Section 1.113-1, Income Tax Regs. (1954 Code), 3 and section 39.22(b)(14)-1, Regs. 118 (1939 Code), did no more than confine mustering-out payment exemptions to those Acts providing for such payments wherein Congress had expressly made a designation. The clear fact *175 is that Congress did not provide tax-exempt status for readjustment payments received under Pub. L. 87-509. See also P. H. Marcum, 10 B.T.A. 1192, 1194; I.T. 3790, 1946-1 C.B. 50; Rev. Rul. 58-496, 1958-2 C.B. 20; and Marshall v. United States, 77 F. Supp. 182 (E.D. La. 1948). In the latter case, the question was whether $ 2,116.67 received by the plaintiff under the provisions of the Naval Aviation Cadet Act of 1942 was excludable from gross income as a mustering-out payment under section 22(b)(14) of the 1939 Code. In holding for the Government, the court said, in part: In the Mustering-Out Payment Act of 1944 it is expressly provided that the payments due or to become due under that act shall be exempt from taxation, but there is no such provision in the Naval Aviation Cadet Act of 1942. * * * *176 Accordingly, we hold that the $ 12,600 is not exempt from taxation under section 113, supra. Petitioner cites the case of Commissioner v. Duberstein, 363 U.S. 278 (1960), in support of his position that the payment of $ 12,600 was a gift, excludable from gross income under section 102(a), 4 I.R.C. 1954, in that it proceeded from a "detached and disinterested generosity" and "out of affection, respect, admiration, charity or like impulses." Utilizing the language of the Duberstein case, petitioner states that: The parties seem to be in agreement that the payment made to petitioner was motivated by a "detached and disinterested generosity" and by "charity or like impulses." *604 We do not agree with petitioner that the payment was a gift. There is nothing in the House or Senate reports 5 to indicate that Congress*177 intended the "readjustment payment" provided for in Pub. L. 87-509 as a "gift" as the term "gift" is used in section 102, supra. The "Committee Action" on H.R. 8773 was stated in S. Rept. No. 1096, in part, as follows: (c) The Department recommended that persons who had received readjustment pay and subsequently qualified for retired pay under any provision of law be required to repay two-thirds of the readjustment payment before receiving retired pay. * * * The committee recommendation is that for those persons who qualify for retired pay based on 20 years of active duty after having received readjustment payments, three-fourths of the readjustment payments must be repaid before the person begins the receipt of retired pay. The reason for not requiring full repayment is that without considering the taxes paid on the readjustment pay a Reserve would be required to repay more than the net he had received as readjustment pay. Since the tax consequences for different Reserves would vary, depending upon their other income, the committee decided that a three-fourths repayment is reasonable. [Emphasis supplied.] *178 It would seem from the emphasized portion of S. Rept. No. 1096, supra, that Congress really assumed that the readjustment payment being provided for would be taxable. We hold that the readjustment payment was not a gift. Cf. P. H. Marcum, supra. In his brief, petitioner presents two alternative contentions: (1) That if the payment involved is held to constitute taxable income, it should be taxed as capital gain and not as ordinary income, and (2) that if the payment involved is held to constitute ordinary income, subject to tax, and not capital gain, then it should be taxed, subject to the provisions of section 1303, I.R.C. 1954, as that section existed in 1963. We see no merit in either alternative contention. Under (1) petitioner argues that petitioner's expectation of retirement benefits from the Air Force was a substantial asset, valued by him at approximately $ 84,000 and that his exchange of that asset for a cash settlement of $ 12,600 was a transaction involving a capital asset. The fact is petitioner had no rights to retirement pay until he had served 20 years *605 of active duty. He had only served a little less than 15 years. *179 The parties stipulated: 9. Petitioner, as of the date of this Stipulation of Facts, has never re-enlisted in the Armed Forces of the United States and is not entitled to retirement pay. Accordingly, we hold that petitioner's capital gains argument is without merit. Under alternative contention (2), the material provisions of section 1303, as it existed in 1963 and prior to the amendments made in the Revenue Act of 1964, Pub. L. 88-272 (Feb. 26, 1964), H.R. 8363, 78 Stat. 19, 105-112, are in the margin. 6 *180 The readjustment payment here in question was not "back pay" as that term is defined in section 1303(b). Petitioner had no right to receive the readjustment payment until he was involuntarily released from the services. In this regard, see Rev. Rul 58-496, supra, cited with approval in Leland W. Woolard, supra, holding that lump-sum severance pay received under the Officers Personnel Act of 1947, 10 U.S.C. chs. 335, 573, 835, does not constitute "back pay" under section 1303. Furthermore, the readjustment payment was pursuant to the mandatory provisions of a statute and, therefore, was not "ordered, recommended, or approved" by any Federal agency as required by section 1303(b), supra. Cf. Francis T. Donahoe, 22 T.C. 1276. Accordingly, we hold that petitioner's "back pay" argument is also without merit; and that the respondent did not err in increasing petitioner's taxable income, as reported, by the sum of $ 12,600 received by him during 1963 as readjustment pay pursuant to Pub. L. 87-509. Decision will be entered for the respondent*181 . Footnotes 1. SEC. 113. MUSTERING-OUT PAYMENTS FOR MEMBERS OF THE ARMED FORCES. Gross income does not include amounts received during the taxable year as mustering-out payments with respect to service in the Armed Forces of the United States.↩ 2. SEC. 109. EXCLUSION FROM GROSS INCOME OF MUSTERING-OUT PAYMENTS FOR MILITARY AND NAVAL PERSONNEL. Section 22(b) [of the Internal Revenue Code of 1939] (relating to exclusions from gross income) is amended by inserting at the end thereof the following: "(14) Mustering-out Payments For Military and Naval Personnel. -- Amounts received during the taxable year as mustering-out payments with respect to service in the military or naval forces of the United States."↩ 3. Sec. 1.113-1 Mustering-out payments for members of the Armed Forces. For the purposes of the exclusion from gross income under section 113 of mustering-out payments with respect to service in the Armed Forces, mustering-out payments are payments made to any recipients pursuant to the provisions of 38 U.S.C. 2105↩ (formerly section 5 of the Mustering-out Payment Act of 1944 and section 505 of the Veterans' Readjustment Assistance Act of 1952). 4. SEC. 102. GIFTS AND INHERITANCES. (a) General Rule. -- Gross income does not include the value of property acquired by gift, bequest, devise, or inheritance.↩ 5. H. Rept. No. 1007, 87th Cong., 1st Sess. (Aug. 22, 1961), accompanying H.R. 8773 and S. Rept. No. 1096 (Sept. 20, 1961).↩ 6. SEC. 1303. INCOME FROM BACK PAY. (a) Limitation on Tax. -- If the amount of the back pay received or accrued by an individual during the taxable year exceeds 15 percent of the gross income of the individual for such year, the part of the tax attributable to the inclusion of such back pay in gross income for the taxable year shall not be greater than the aggregate of the increases in the taxes which would have resulted from the inclusion of the respective portions of such back pay in gross income for the taxable years to which such portions are respectively attributable, as determined under regulations prescribed by the Secretary or his delegate. (b) Definition of Back Pay. -- For purposes of this section, the term "back pay" means amounts includible in gross income under this subtitle which are one of the following -- * * * * (2) Wages or salaries which are received or accrued during the taxable year by an employee for services performed before the taxable year for his employer and which constitute retroactive wage or salary increases ordered, recommended, or approved by any Federal or State agency, and made retroactive to any period before the taxable year.↩